Build Retirement Savings and Manage Your Estate

When it comes to saving for retirement and estate building, the Roth IRA is a superhero of the investment world. Though perhaps less well known than the traditional IRA or workplace 401(k) plans, Roth IRAs can be a powerful tool to augment the savings achieved through those vehicles.

What sets the Roth IRA apart is that it is funded with after-tax contributions and once distributions start, they are tax free. So, while the Roth IRA does not provide a tax deduction during your saving years, it does provide tax-free income in retirement.

The Roth IRA was created by Congress in 1997 primarily as a retirement savings tool. However, it fits into multiple buckets as a savings vehicle. As we look at our clients’ unique situations, we consider it as part of tax planning, cash management, income planning, and estate planning.

Roth IRAs have other characteristics that make them attractive both as savings vehicles and estate planning tools:

  • Since qualifying distributions are tax free, there are no required minimum distributions such as those that apply to traditional IRAs and workplace retirement plans such as 401(k), 403(b) and 457 plans. You may leave the money in your Roth IRA for as long as you want and allow it to grow, building your estate.
  • Once it is established, you must allow it to grow without making any distributions for at least five years. After that, you are free to make distributions.

There are some income limitations to keep in mind regarding Roth IRAs. For 2022, a single taxpayer can make a full contribution with an adjusted gross income (AGI) up to $129,000, and a partial contribution between $129,000 and $144,000. Married joint filers may make full contributions with AGI up to $204,000 and a partial contribution between $204,000 and $214,000.

A full contribution is $6,000 annually, or $7,000 for taxpayers aged 50 and older.

If you’re employed and your workplace retirement plan is your primary savings vehicle, you should consider deferring income to it at the highest possible level. Some employers offer a feature called a Roth 401(k) within their traditional 401(k) plans that can add fuel to your long-term savings plan. Since there are no income limits for this type of Roth, high earners can benefit from it. However, this only applies if your company has a Roth 401(k) option within its retirement plan.

Back-door Roth Option

Another strategy exists to enable high earners to participate in Roth IRAs. It’s a complicated workaround and could go away soon, as the current presidential administration has proposed eliminating it. The so-called “backdoor Roth option” is achieved by making a non-deductible Traditional IRA and then shifting the money to a Roth IRA. Even though you may not have income eligible to establish a Roth IRA through the front door, this is a powerful tool to get money into that after-tax bucket. Time is of the essence, however, since this option may soon disappear.

Valuable Tool for Young Savers

Roth IRAs are particularly valuable for young savers because of the tax-free growth they provide. Historically, we expect tax rates to rise over time. If you prepay the taxes on your retirement savings at today’s rates while you are young and in a lower tax bracket, it will significantly enhance the value of your tax-free distributions later.

Estate Planning Tool

If you’re retired and you have income from various sources, you may find yourself bumping up against income limits that could kick you into a higher tax bracket. You can use a Roth IRA as a tax control device by coordinating your taxable distributions and non-taxable distributions from your Roth to keep you from bumping into that next bracket. This is part of proactive management, and we strongly advise clients to have both buckets of money – pre-tax and after-tax – for tax control later.

What To Do Now

If you don’t already have a Roth account, there is no better time than now to determine how one may help you achieve your savings goals. Saving for retirement and for estate building requires setting both financial and life goals. Don’t put so much away for tomorrow that you’re not enjoying life with your family and loved ones today; conversely, you can’t put so much of your money into having fun today that you’re not planning for tomorrow.

Contact your Adams Brown wealth consultant for a conversation about how you can find the right balance to meet your goals.